JOURNALS OF ROBERT MAAS

Wednesday, November 23, 2016

HMRC's "hardline" decision to collect tax due nine years ago

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176

HMRC’s “hardline” decision to collect tax due nine
years ago

Last Saturday’s Times contained what
seems to me to be an extra-ordinary article by Alexi Mostrous, their Head of
Investigations. It began, “The hardline
decision by HM Revenue & Customs to issue huge tax demands to hundreds of
wealthy investors in the Eclipse film partnerships marks the culmination of a
four-year campaign against such avoidance schemes”.

The complaint seems to be that those
wealthy individuals are being asked to pay the tax and interest on their income
but they have spent all the money on the assumption that their tax avoidance
scheme would work. Accordingly many are
facing bankruptcy and some are considering suicide. I am not clear what Mr Mostrous thinks HMRC
should do. HMRC are required to collect
the tax that Parliament decrees. Doing
just that does not strike me as a hardline decision.

I have never made a secret of my views
on tax avoidance. I do not think that
there is any morality in tax. Tax is a
creation of statute. If the statute says
that transaction A attracts £X of tax, the tax ought to be paid. If the statute says that transaction B
creates an expense that can be deducted in calculating the tax on transaction
A, the taxpayer is entitled to make that deduction. There are numerous cases where HMRC collects
tax that is not morally due. Regular
readers of this blog will know that I highlight some of these from time to time. HMRC’s rationale is that they have a duty to
collect the tax parliament lays down, however unreasonable that impost may be.

I think that works both ways. If a person seeks to avoid tax and his scheme
fails, he should pay the tax that he sought to avoid. He is not entitled to look for special
treatment because he has spent the money.
Thousands of people who have never attempted to avoid tax do not set
aside the tax money but spend it on other things and face financial hardship
and bankruptcy when the time to pay the tax arrives and their coffers are
bare. I am not aware of Mr Mostrous
having ever proclaimed it “hardline” for HMRC to seek to collect the tax from
such people.

In practice HMRC do not like to bankrupt
people. That reduces the person’s
earning capacity and therefore their ability to pay future tax. HMRC are normally willing to enter into a
time to pay arrangement. But they do
expect the taxpayer to do his best to pay the tax as quickly as is
practicable. They do expect a wealthy
individual to realise assets, to re-mortgage his house, to downsize to release
funds, or whatever else is needed to produce the cash. If a person lives an expensive lifestyle and
has accumulated assets, it would surely be an affront to the general body of
taxpayers to allow the person to continue to live the high life using money
that is due to the Exchequer.

What have these wealthy taxpayers who
have gained Mr Mostrous’s sympathy done?
The Eclipse Film Partners No 35 tax avoidance scheme was won by HMRC in
the Court of Appeal in February 2015. The
Supreme Court refused leave to appeal on 13 April 2016. They normally refuse leave only where they
believe that the decision of the Court of Appeal is so obviously correct that
there is no public interest in its being challenged.

The scheme related to the tax year
2006/07. The members of the partnership
collectively put £50million of their own money into it and also put in an extra
£790million that they borrowed from a subsidiary of Barclays Bank. The partnership paid £44m to Future Films,
the promoter of the scheme. Accordingly virtually
none of the members’ £50million went into films. The scheme was nothing to do with the members
helping the film industry; any such help came from Barclays Bank. The partnership lent £293m of Barclays Bank’s
money to the members as an advance against future profits and the members paid
that money back to Barclays Bank as a prepayment of 10 years interest on their
loans.

The scheme was a deferral scheme. The idea was that Barclays’ money would be
used to buy film rights from Disney Corporation which would then be licenced
back to Disney for 20 years. The licence
fee would be income of the partnership and as such taxed on the partners. However the partners would never see that
money; it would be used to repay the Barclays Bank loan. Accordingly the members thought (or if they
did not understand the scheme, should have thought) that they would get tax
relief in 2006/07 but would have taxable income in each of the next 20 years
for which they would have to fund the tax out of their own resources (or, of
course, enter into further tax avoidance schemes each year to seek to shelter
that income from tax) as the income itself had to be paid to Barclays.

In general the UK tax system does not
grant tax relief for interest on borrowings to make investments. You do not get tax relief for interest on the
mortgage to invest in your house; you do not get tax relief for interest on a
borrowing to invest in shares in, say, BP even though you expect the investment
to produce taxable dividends; and you do not get tax relief for interest on a
borrowing to invest in film rights even though you expect those rights to produce
taxable licence fees. (Curiously if you rent your house and borrow to invest in
someone else’s house you do get tax relief on the interest by treating it as an
expense of generating the rental income.
Personally that does not seem either rational or moral, but it is what
parliament in its wisdom has decided and, as I said earlier, in my view we
ought to/are entitled to take the tax system as we find it).

If I carry on a trade, I do get tax
relief for interest on money that I borrow for the purpose of the trade. It is a business expense. If a partnership carries on a trade, a
partner can claim tax relief on interest on money that he borrows to finance
the trade (presumably parliament feels that such interest is in reality a
trading expense of the trade). The
members of Eclipse 35 believed it was carrying on a trade so that they could
set their advance loan interest payments against their overall income for
2006/07. The Courts have held that the
partnership’s activities were an investment in film rights, not a trade. Accordingly they have no right to tax relief
for the interest payment in the same way as no one else has a right to tax
relief on money borrowed to make an investment.

The issue that seems to have attracted Mr
Mostrous’s sympathy is that by now the investors owe tax not only on the £293m
income of 2006/07 that they sought to shelter by the interest payment, but they
have “received” getting on for half the leasing receipts on which they also owe
the tax (as they always expected to do).
These investors have known since April that the tax was due - and
because all of the First-tier Tribunal, the Upper Tribunal and the Court of
Appeal have held that the partnership did not carry on a trade, they have at
least known the tax might be due since the FTT decision in 2012 and so have had
four years to find the money. 2006/07
tax was due for payment by 31 January 2008, which is almost 9 years ago. How much longer does Mr Mostrous think that
the Exchequer should wait for its money?
The tax on the licence fees would have been payable even if the
activities had amounted to a trade so it is not clear why the partners should
still owe the money. They ought to have
been declaring that income and paying the tax on it year by year.

A judge once commented in relation to
tax avoidance that he who plays with fire cannot complain of burnt
fingers. That seems to me to be
precisely what the investors in Eclipse 35 are now doing. They want to say the whole thing was a
ghastly mistake and HMRC ought to pretend nothing happened and simply collect
tax on the £293m. But that is an
extra-ordinary concept. They entered
into real transactions and even convinced the Courts that they were real, not
pretend transactions. They may not like
the tax consequences of those real transactions but it is not reasonable to
criticise HMRC for enforcing those consequences.

HMRC are not being hardline. They are simply enforcing the laws laid down
by parliament. That is what they are
there to do. Of course parliament could
change the laws. Mr Mostrous can write
to his MP and suggest that parliament should retrospectively exempt from tax
those wealthy investors who sought to avoid it and have spent the money because
they felt that their fair contribution to society is somewhat less than
parliament has decreed. That would be a
perfectly legitimate thing to do. I
somehow doubt that parliament would think such a suggestion reasonable though!

Monday, November 14, 2016

UNRAVELLING THE TAX GAP

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UNRAVELLING THE TAX GAP

HMRC recently issued a note about
calculating the 2014/15 tax gap. This
tells us that the tax gap for 2014/15 was some 6.5% of the total tax and duties
due to HMRC. It also says that “the
estimate announced for the previous year has been revised upwards from £34bn to
an actual figure of £37bn”.

I am not sure that it is helpful for the
government to lie to the citizenry. But
I suppose that when it ought to be obvious that it is a lie – as it is surely
not possible to “estimate” an “actual figure” that may not matter too
much. One can replace an estimate by an
actual figure and one can refine an estimate to produce a more accurate
estimate – which is what HMRC have done – but there will always be a
fundamental difference between an estimate (an educated guess) and an actual
figure (a fact).

The briefing note is of course little
more than an advertising puff for the full 86-page report, which is a lot more
honest. So what is the tax gap? HMRC say it is the difference between the
amount of tax due and the amount collected.
They point out that it is impossible to collect every penny
theoretically due, “for example, we cannot legally collect taxes from companies
that owe tax and are insolvent”. I like
that word “legally”. If HMRC believe
that there are illegal ways to collect tax from people who have no money,
perhaps they should explain what they are.
In the real world if a person has spent all his money he cannot pay
anything. But I digress. The full report breaks down the tax gap as
follows.

Criminal attacks £4.8bn 13%

Evasion 5.2bn 14%

Hidden economy £6.2bn17%

£16.2bn 44%

Avoidance 2.2bn 6%

Non-payment 3.6bn 10%

Legal interpretation £5.2bn 15%

Failure to take reasonable care
5.5bn 19%

Error £3.2bn£13.9bn
9%

£35.9bn103%

I have totalled the first three items
together because they are all different forms of theft. I assume that HMRC have split them because
they try to counter them in various ways.

This is an interesting table. 44% of the £6.5bn shortfall, or £2.86bn is
lost due to theft. That is obviously an
estimate. If HMRC knew how much had been
stolen from taxpayers they would also know who stole it and would presumably
recover it. The reality is that they do
not know, because nobody knows. Many put
the figure much higher.

Bearing in mind the vast amount of both
government expenditure and new legislation designed to combat tax avoidance, it
is interesting to learn that this actually cost taxpayers only £2.2bn in
2014/15 and represented a mere 0.39% of the tax shortfall. Indeed the vast majority of this figure is
not a shortfall at all. It will be
collected (with interest at a rate that exceeds a commercial rate) in later
years because most attempted tax avoidance fails and the tax has to be paid (or
will fall into HMRC’s non-payment category) in a later year. Where avoidance is successful, it is not part
of the tax gap either (under HMRC’s definition) as the tax will never have been
“an amount of tax due”; it is an error in HMRC’s calculation of the tax due,
arising from a misunderstanding by HMRC of the tax laws.

Non-payment is factual and there is not
much to say about it; even HMRC cannot stop people becoming insolvent.

The three remaining items are all
estimates. How accurate they are is
questionable. HMRC enquire into a small
number of cases. Those enquiries throw
up areas where the taxpayer has taken a different view from HMRC. In most cases the two sides compromise. HMRC then consider imposing a penalty for the
extra tax that becomes collectible as a result of their challenge. If the taxpayer accepts a penalty, that extra
tax is labelled as arising from failure to take reasonable care; if he doesn’t,
it is attributed to error. If the
dispute has not been resolved by the time HMRC prepare their statistics, the
tax HMRC are claiming is labelled as lost due to legal interpretation. The statistics are generally based on HMRC
random enquiries. They do a very tiny
number of random enquiries. I do not
know how many but I would be surprised if it is more than 1,000. They then assume that the extra tax they pick
up from that small number is representative of the whole body of
taxpayers. So if they pick up extra tax
on, say, 200 of their 1,000 random enquiries they assume that 20% of the 9
million tax returns they receive are similarly wrong. That may or may not be a correct
assumption. I have no doubt that it is a
statistically reasonable one.

The legal interpretation category is a
bit more controversial because most challenges of legal interpretations take
years to resolve. Some, or indeed all,
of that £5.2bn may be tax that will ultimately be collected. It may equally not be tax at all but an
amount that HMRC thought was due because they misunderstood the law. This means that projecting from the sample to
the general body of taxpayers is fairly pointless. It is improbably that other taxpayers will be
interpreting or misinterpreting exactly the same bits of legislation.